Your Social Security by Tom Margenau

Q: I just got my annual statement of projected Social Security benefits and it got me to wondering how Social Security retirement benefits are calculated. Can you explain?

A: The basic definition of a Social Security retirement benefit is relatively simple. It's a percentage of your average monthly income indexed for inflation over a 35-year time span. But as you might guess — this is a government program after all — putting that simple definition into practice gets really complicated.

I'll work backward with the basic definition to help explain it.

Over a 35-year Time Span: Despite rumors to the contrary, Social Security does not base your retirement benefit on your last 10 years of earnings, or your highest three years of earnings. For all people retiring now and in the future, a 35-year block of earnings is used. That doesn't necessarily mean your last 35 years of earnings. When you retire, the Social Security Administration looks at your complete earnings history and pulls out the highest 35 years.

Note: For the annual statement you get from SSA, they project your earnings into the future (based on your most recent annual income) to get the 35-year base needed.

Indexed for inflation: Before SSA selects your "high 35," they index each year of earnings for inflation. And the set of indexing factors they use for each year varies with your date of birth. And all those factors are updated annually to adjust for inflation.

For example, if you were born in 1946 and made $20,000 in 1980, SSA multiplies your actual $20,000 in earnings by an indexing factor of 3.09. So the inflation-adjusted 1980 earnings SSA would use in your retirement computation is $61,800 ($20,000 times 3.09 equals $61,800).

However, if you were born in 1942 and made the same $20,000 in 1980, SSA would multiply those earnings by an indexing factor of 2.66, meaning they would use $53,200 in inflation-adjusted earnings in your computation.

Note: The annual statement you get from SSA shows your actual earnings.

SSA uses the inflation-adjusted earnings only in your retirement computation.

SSA publishes the indexing factors for people born between the years1935 and 1946 at its website. Go to www.socialsecurity.gov/pubs/10070.html.

Average Monthly Income: This is the easiest part of the Social Security benefit formula. Once you know your highest 35 years of inflation-adjusted earnings, add them up and divide by 420, the number of months in 35 years. That will give your average inflation-adjusted monthly earnings.

"A Percentage Of: This is where we get into the "social" part of Social Security. SSA multiplies your average monthly income by a percentage that varies depending on your economic status.

The benefit formula is weighted to give low-income people a better deal than people in higher wage brackets. They don't get more money; they just get a better deal. For example, the very lowest wage earners could get a Social Security benefit that represents up to 90 percent of their pre-retirement income. Those who have consistently paid maximum Social Security taxes will see about a 25 percent return rate, while most middle-class Americans get a 40 percent rate of return. Experts call this the "replacement rate."

And as with the inflation indexing factors used to figure the average wage, the replacement rate varies depending on your year of birth and all the rates are updated annually. SSA publishes the replacement rates for people born between 1935 and 1946 at www.socialsecurity.gov/pubs/10070.html.

To find out more about Tom Margenau and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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